The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

Have you been checking Where’s My Refund? impatiently for the status of your 2013 tax refund from the Internal Revenue Service? Then maybe you’ll have some sympathy for Texas billionaire banker Andrew Beal who is still dancing with the Feds over $152 million in refund claims for 2002 through 2009.

Or maybe not. After all, the claims all relate to Beal’s use of an abusive tax shelter the IRS calls Distressed Asset Debt, or DAD, to manufacture billions of bogus tax losses from junk Chinese debt.

Beal’s refund wait might soon be over. Yesterday, lawyers for Beal and the Department of Justice filed a joint motion in federal court in Dallas saying they had reached a global settlement of 12 Beal lawsuits related to his refund claims. No details of the deal, which still must be approved by DOJ brass, were disclosed in the filing and an attorney for Beal declined comment. But it’s entirely possible the government could soon be cutting a check even bigger than the $49.5 million refund it sent Beal last July.

Intrigued? The back story is one of those convoluted tax tales that shows how different the rich are when it comes to taxes. It also shows why it can pay to fight the IRS in the famously taxpayer-friendly 5th Circuit as opposed to the more IRS-friendly U.S. Tax Court.

In a DAD shelter, a U.S. taxpayer forms a partnership with a foreign owner of non-perfoming loans and then claims huge tax losses from the partnership---loses the foreign lenders, but not the U.S. taxpayer, sustained. The DAD technique spread among the wealthy in 2001, 2002 and 2003 after the Internal Revenue Service began a crack-down on better known abusive tax shelters, such as Son of Boss, marketed in the late 1990s. (In addition to Beal, billionaires Henry T. Nicholas III, the co-founder of and Shahid Khan, the auto parts magnate who owns the NFL Jaguars, did DAD deals, albeit on a smaller scale than Beal.)

In 2004, after the IRS got wind of DAD, Congress changed the tax code to explicitly bar partnerships from being used to transfer foreign losses to U.S. taxpayers. Meanwhile, the IRS began auditing existing DAD partnerships, disallowing all their losses as shams and slapping on penalties. (Partnerships pay no taxes themselves. Instead, all their profits and losses, as well as any tax penalties on bogus claimed losses, flow though to their owners’ individual 1040s. So the penalties—either 20% or 40% of the extra tax-- apply only to those losses which an individual taxpayer actually claimed.)

Beal had created four separate DAD partnerships in 2002 and 2003 to hold non-performing loans made by the Chinese government, with the aim, the government says, of stockpiling $4 billion in artificial losses to shelter income. (Even for Beal, whose net worth is an estimated $11.3 billion, $4 billion can offset income from more than a few years.)

With the IRS on the audit warpath, in 2006 and 2011 Beal deposited hundreds of millions of dollars to cover the back taxes, interest, penalties and penalty interest the auditors were likely to demand. That had two advantages---it stopped interest from accruing and it allowed Beal to later fight the IRS in the federal district court in Texas and in the 5th Circuit Court of Appeals. (Taxpayers who haven’t paid up must battle the IRS in U.S. Tax court; refund suits are filed in district court.)

In October 2011, a three judge appeals panel from the 5th Circuit ruled on Beal's first case---a 2002 tax return filed by Southgate Master Fund LLC. In their decision, the judges nixed Beal's attempt to claim $1.1 billion in tax losses from an investment of just $19 million in distressed Chinese debt, finding (as had the district court) that the partnership was a sham that should be disregarded for tax purposes. But the panel also ruled that Beal’s acquisition of junk Chinese debt had “economic substance” because—and this sounds bizarre if you’re not a tax geek---he had a reasonable chance of making a real profit, even as he angled to claim big losses. As a result, the court allowed Beal to deduct his actual expenses and losses on the Chinese junk, but not the bigger losses the Chinese had sustained.

Even more significantly, both the district court judge and the appeals panel held Beal wasn’t liable for any penalties because he had opinions from both a law and an accounting firm concluding that it was “more likely than not” that the partnership ploy would withstand IRS scrutiny. The appeals court called it a “close issue.” The trial judge had no such reservations, writing, “Beal is an aggressive risk-taker, a noted gambler who makes big bets. Sometimes he wins, and sometimes he loses—but he plays the game above board.” It surely helped Beal’s case that (unlike most DAD users) he had made his fortune investing in distressed U.S. assets and had even invested in distressed assets abroad before. That made it a bit more plausible when he argued he went into the shelter thinking he might make a profit. (Other DAD users have had less success convincing judges that they shouldn't pay penalties.)

Since the appeals decision became final in February 2012, Beal and the DOJ have been fighting over how much Beal should get back. Last July, the IRS sent him a $49.5 million check for penalties he’d paid for claiming Southgate’s 2002 losses---the case that the 5th Circuit decided. (Beal wants another $1.7 million for 2002, to take into account the expenses the 5th Circuit said he could deduct.)

For 2003 through 2009, Beal’s lawyers say he should get $99 million in penalties and interest back, plus a $51 million tax refund for the same sort of deductions the 5th Circuit allowed in Southgate. The government, for its part, has maintained that the circumstances of Beal’s three other DAD partnerships and in later tax years might be different---and more penalty worthy.

Each side had already paid a big name tax professor to deliver an expert opinion on whether Beal could rely on those “more likely than not” law and tax firm opinions to escape penalties. New York University Law Professor Daniel N. Shaviro wrote for the government that the opinions in 2003 and beyond were weaker because they were based on “factual premises that had been rapidly losing credibility.” Specifically, they assumed that since Beal had made profits in distressed U.S. assets, he could reasonably expect to make money in the Chinese debt--- which wasn’t turning out to be the case. University of Chicago Law School Professor David A. Weisbach, whose expert opinion helped Beal escape penalties in the Southgate decision, weighed in again for his side.

Perhaps not entirely coincidentally, the settlement was reached the day before Beal's lawyers were scheduled to take depositions from Internal Revenue Service officials---depositions which were put on ice by the last-minute-deal.